The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Bharat Rasayan Limited (NSE:BHARATRAS) trades with a trailing P/E of 30.4, which is higher than the industry average of 18.6. Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
See our latest analysis for Bharat Rasayan
Demystifying the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for BHARATRAS
Price-Earnings Ratio = Price per share ÷ Earnings per share
BHARATRAS Price-Earnings Ratio = ₹7698.05 ÷ ₹253.416 = 30.4x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to BHARATRAS, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. BHARATRAS’s P/E of 30.4 is higher than its industry peers (18.6), which implies that each dollar of BHARATRAS’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 25 Chemicals companies in IN including Anil, Sysco Industries and Mysore Petro Chemicals. You could also say that the market is suggesting that BHARATRAS is a stronger business than the average comparable company.
A few caveats
Before you jump to conclusions it is important to realise that there are assumptions in this analysis. The first is that our “similar companies” are actually similar to BHARATRAS. If not, the difference in P/E might be a result of other factors. For example, if Bharat Rasayan Limited is growing faster than its peers, then it would deserve a higher P/E ratio. We should also be aware that the stocks we are comparing to BHARATRAS may not be fairly valued. Just because it is trading on a higher P/E ratio than its peers does not mean it must be overvalued. After all, the peer group could be undervalued.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in BHARATRAS. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I highly recommend you to complete your research by taking a look at the following: